Unit 5: Financial Statements – Sole Trader
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O Level Principles of Accounts (7110)
Recommended Prior Knowledge
Students should have a thorough understanding of Units 1 to 4 before embarking on a study of this unit.
Context
Financial statements combine the knowledge gained in Units 1 and 4 and a test of this topic conventionally acts as a summary assessment of knowledge acquired
earlier. Financial statements are used in examinations and in practice to highlight organisational performance and position.
Outline
This unit concentrates on financial statements which measure performance in terms of gross and net profit and position (what an organisation owns, owes and what is
owed to it).
AO
Learning outcomes
Suggested Teaching activities
Learning resources
3.1
Candidates should be able to:
Recapitulate on the matching concept and how it affects the:
http://www.staffs.ac.uk/schools/business/bsadmin/staf
f/s5/accsys/wtwo.htm#l1
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calculate the gross and net
profits or losses, based on
accounting principles, for a
specified period
• Trading account section of the income statement
• Profit and loss account section of the income
statement
Explain the differences between the two and what each cover.
When looking at the role of closing inventory, consider
introducing the concept of cost or net realisable value.
It is helpful to students to show them how the information from
the ledgers is transferred by ‘closing’, for example, the sales
and purchases accounts and taking the balances to the income
statement.
A progressive approach assists students in their
understanding, for example:
1) gross profit = sales less cost of sales (opening stock +
purchases – closing stock)
2) including sales returns and purchase returns
Past question papers available from CIE, e.g.
Nov 2003 Paper 1 Q27
Specimen Paper 1 Q16,22
1
AO
Learning outcomes
Suggested Teaching activities
Learning resources
3) including carriage inwards (emphasising carriage
outwards is not included in the trading account section)
and make adjustments for goods taken by owner for
own use
3.1
3.2
Candidates should be able to:
•
recognise that profit (or loss)
for the year is the increase (or
decrease) in the net value of
assets during that period
•
prepare simple columnar
trading account sections of an
income statement when
dealing with a business which
has two departments
Candidates should be able to:
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recognise that a balance
sheet is a statement of
balances of assets and
liabilities on a specified date
set out in any valid layout
demonstrate knowledge of the
meaning, importance and
designation of non-current
assets, goodwill, current
assets, current liabilities,
nom-current liabilities and
working capital
comment upon the
significance of the interrelationship of the Balance
Columnar trading account sections of an income statement
will not be complex in the examination. Practice will help
students gain familiarity with them
Remind students about the accounting equation and use it to
illustrate the effect of changes in assets and liabilities.
Translate this into an expanded accounting equation using a
balance sheet format.
Past question papers available from CIE, e.g.
Nov 2003 Paper 2 Q1
http://www.bized.ac.uk/stafsup/options/accounting/wor
k02.htm
http://www.staffs.ac.uk/schools/business/bsadmin/staf
f/s5/accsys/wone.htm#l1
This can be shown simply using the Quadrant:
Non-current
Assets
Capital
Current
Assets
Current
Liabilities
Take students through the implications of a change in one
quarter on the other quarters.
2
AO
Learning outcomes
Suggested Teaching activities
Learning resources
Working capital is important to a business and a question and
answer session with students allowing them to think through
what would happen to a business which is short of:
Past question papers available from CIE, e.g.
Sheet items
•
relate working capital to the
liquidity of a business
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•
•
Jun 2005 Paper 1 Q27, 28
Cash
Inventory
Ability to obtain credit
will help students understand the content and importance of
working capital.
Candidates should be able to:
•
explain the basis of valuation
of assets as follows:
• non-current assets at cost
less accumulated
depreciation
• inventory at cost or net
realisable value,
whichever is lower
• trade receivables at
expected collectible
amount i.e. after
deduction of provision for
doubtful debts
•
distinguish between, and
show understanding of,
capital and capital employed
Students often have difficulty seeing how changes outside
current assets and current liabilities can affect working capital.
The quadrant may help understanding.
Rules, such as those about asset valuation, are often easier to
learn by considering examples. Students should be able to
explain terms e.g. the meaning of ‘cost’ or ‘net realisable
value’.
Students can easily become confused by the term capital when
used in a different context:
• Capital
• Capital employed
• Capital expenditure
• Working capital
Past question papers available from CIE, e.g.
Nov 2003 Paper 1 Q25
Nov 2005 Paper 2 Q3(e)
Jun 2003 Paper 2 Q4
3
AO
Learning outcomes
Suggested Teaching activities
Learning resources
Time is well spent testing students on the differences so that
they are clear about the different terms and what they mean.
4.1
Candidates should be able to:
Examples of local business can be used to illustrate/check
understanding. Students could be asked to prepare a list of
organisations providing business and consumer services
Past question papers available from CIE, e.g.
•
explain the difference
between a trading and a
service business
•
prepare Income Statements
and Balance Sheets for
trading businesses
prepare Income Statements
and Balance Sheets for
service businesses
At this stage, students have looked at the individual aspects of
the financial statements. Illustrate and provide practice for
students to help them see how the individual elements fit
together. Although much teaching will involve sole trader
businesses, students should be aware, as they progress
through their studies, that similar accounts and statements are
used, as appropriate, for all organisations.
http://www.staffs.ac.uk/schools/business/bsadmin/staf
f/s5/mscproj/defn.htm
make adjustments for
provision for depreciation
using the straight line,
diminishing (reducing)
balance and revaluation
methods
make adjustments for
provisions for doubtful debts
make adjustments for other
payables and other
receivables to take account of
accrued and prepaid
expenses and outstanding
and prepaid income
make adjustments for goods
taken by owner for own use
There should be examples of all of these various adjustments
from earlier units which can be brought in here to again
illustrate to students the interconnected nature of the ledger
and financial statements and how double entry principles are
applied throughout.
http://accounting10.tripod.com/content.htm
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Jun 2003 Paper 2 Q4
Past question papers available from CIE, e.g.
Nov 2003 Paper 2 Q6
Jun 2003 Paper 2 Q5
Nov 2005 Paper 2 Q5
4